How elections can swing markets

April 06, 2009 11:36 IST

Given the sluggish macroeconomic scenario, the markets are hoping for an alliance that could provide stability and move the reform process ahead.

Elections are an important event for the country given its impact on the corporate sector, individuals and markets. This time around, if experts are to be believed, the importance of elections has only risen as they expect a fractured verdict with no single party garnering a meaningful majority.

Although it is too early to guess the outcome as well as how many seats the individual parties would secure, markets are more concerned about economic stability and continuity in reforms, which would drive growth in future.

So, expect markets to remain volatile as the poll dates come closer as well as if uncertainty prevails post-May 2009. History is proof of this. In 2004 elections, the BJP-led NDA government lost power paving way for the Congress-led UPA to form the new government at the centre completely surprising the market. Firstly, the markets were expecting the NDA to stay in power.

And secondly, the UPA government was supported by the Left parties raising questions regarding stability and policies of the new government. The result was that, on 17th May, 2004 the Sensex made an intra-day low of 4,227, which was over 16 per cent lower as compared to its previous close of 5,070 per cent. Thereafter, once it felt confident about the future prospects and growth rates improved, it secured new highs.

This time around, however, the key concern is that the economy is not in good shape and requires some bold initiatives if it has to once again grow robustly. Thus, the need for a strong and stable government at the centre is even higher. Read on to know the possible scenarios, and what it could mean for the markets.

Congress-led alliance

One of the important things during UPA's tenure was the support from parties like the Left parties, Lalu Prasad's Rashtriya Janata Dal (RJD), Nationalist Congress Party (NCP) and Dravida Munnettra Kazhagam (DMK). Then, the Congress had only 145 seats. This time, its biggest alliance partner (the Left) has departed to form a Third Front.

Also, the performance of the Samajwadi Party in Uttar Pradesh (accounts for 80 seats) will count as Mayawati's Bahujan Samaj Party (BSP) is seen to have an upper hand. Similarly, its alliance partners like RJD and NCP are yet to fully confirm their support, but are open to do so post-elections.

Nevertheless, the markets will give a thumbs up to a Congress-led UPA. Its manifesto lists economic revival and restoring high growth as its immediate priority. It also mentions that public expenditure on agriculture and infrastructure will be stepped up. Experts also expect policies in the nuclear power and related segments to gain traction.

They believe that UPA's policies towards allowing FDI in insurance, telecom and retail sectors have been good. On the flip side, experts indicate the lack of sufficient reforms in the past in areas like fuel pricing (still administered) and PSU divestment. Concerns also exist on how it will tackle the growing fiscal deficit.

However, all will depend on the combination of partners, which will ultimately have a bearing on the depth and execution of policy initiatives. And, this holds true for any coalition - UPA, NDA or the Third Front.

BJP-led alliance

Although, the BJP-led NDA is the other contender for forming the next government, the expected poor performance in Rajasthan and MP could pose some challenges. Additionally, since its large ally, Biju Janata Dal (BJD) in Orissa, has departed, the alliance will have to make up for this loss of 11 seats.

Meanwhile, while there are challenges before the party, how the alliance shapes up post elections  ability to rope in parties like BSP  will be crucial. Also, "if the Third Front is not supported by the Congress, it might lead to a split in Third Front, which could be good news for NDA," says Shekhar.

Meanwhile, on April 3, the BJP declared its manifesto mentioning income tax exemptions for individuals with an annual income of Rs 3 lakh and Rs 3.5 lakh for women. This could mean higher disposable incomes for individuals, and thus, increased consumption of consumer durables, automobiles, travel, FMCG and entertainment among others.

Its manifesto also indicates lower interest for farmers and certain housing categories besides, abolition of fringe benefit tax. This in turn, indicates gains for companies catering to rural India, as well some gains for India Inc.

Additionally, while the market believes that NDA, too, has similar policies towards agriculture, infrastructure and for reviving the economy, it has also been pro-divestment in the past. Thus, one could expect divestment of non-core PSUs as well as enhanced reforms to strengthen remaining companies.

Emergence of Third Front

The growing strength of Third Front, which has already upped its ante against the BJP and the Congress, is also a reason for experts now realising its impact on election results and subsequent government formation.

"The possibility of the Third Front emerging strong has increased over the past month given the alliances and seat sharing agreements across parties (like BSP, AIADMK, TDP, NCP)," says, Nischal Maheshwari, head research, Edelweiss Securities.

"There is high probability that the Third Front might come into the picture including the left parties. In that case, there would be lot of uncertainty and chances are high that significant or crucial ministries like finance and external could go to the Third Front," says Shekhar. Also, due to the involvement of a large number of parties, it could lead to instability and distorted policies.

We have already seen this in the past during 1989 (V P Singh government) and 1996-97 (H D Deve Gowda) supported by the Third Front.

But, both these governments had short life spans and there was uncertainty in the markets during these periods. Notably, the Third Front manifesto claims that it would restore long term capital gain tax and abolish STT (on equities) and remove tax concessions given to some sectors like IT, which may not go down well with the market.

Although, they will also focus on infrastructure, rural development and agriculture, experts believe that its policies towards SEZ, foreign trade, FDI and FII (in certain sectors) and PSU divestments may not be market-friendly.

What should you do?

As of now, most experts believe that the election results could be extremely fractured where no party will have a majority.

They say, based on the seats won by individual parties, alliances and negotiations among parties (besides Congress and BJP, there are a large number of big and small regional parties which account for almost 50 per cent of total Lok Sabha seats) would intensify and will also play a crucial role in portfolio (ministry) allocation, thus its impact on the markets.

"There could be lot more volatility in the market with a downward bias once the elections are over," says Satish Ramnathan, head equities, Sundaram BNP Paribas Mutual Fund.

"It is surprising to see the markets rally despite the looming uncertainty due to elections and fourth quarter results, which are expected to be as bad as we have seen in quarter three," says Ambareesh Baliga, VP, Karvy Stock Broking. In this context, what should investors do? Baliga advises, "Book profits and sit on some cash. I will rather invest at 10 per cent higher levels. At least at that point in time we will have some clarity as to who is forming the government and their policies."

Likewise, experts say, to deal with volatility, investors could hedge their existing portfolios by taking some suitable derivatives (options) exposure.

Besides, investors can avoid cyclicals and cling on to some defensives like FMCG, utilities and pharma. Exposure to infrastructure and agri-based companies, where revenue visibility is higher and which is the focus of all political parties, should prove beneficial.